In the first two parts of this series, we looked at consulting firm valuations, the mergers and acquisitions market, and the eight equity levers used in a valuation assessment, which consulting firm owners also use as a tool to increase the equity value of their businesses.
Now we’re going to complete the picture by looking at the most important qualitative factors influencing an investor’s perceived value of your business, and discuss the key considerations in taking your firm to market.
What does a well-run firm look like to an investor?
As far as any potential investor in the firm is concerned, if you can forecast top-line sales revenue with accuracy then there’s a high probability that you can forecast profits. Consistent and reliable growth in profits is the main driver of equity value and has a major influence on the multiplier applied. That’s why the quality of the sales and marketing machine is vital in the valuation equation.
The most important factor in maximising the value of your consulting firm is your ability to forecast sales revenues.
Firms without a good quality sales and marketing process cannot reliably predict sales revenue. In fact, some don’t have a sales and marketing process at all. In the typical small consulting firm, sales happen serendipitously through a process that can best be described as ‘network selling’. That is good, but it’s not enough on its own.
There’s too much of a reliance on people and referrals, which increases the risk of ‘feast and famine’ and saw-tooth sales revenues. Firms with this approach to sales and marketing present a very risky profile for an investor because of their complete reliance on erratic and unreliable sources for their sales pipeline.
On the other hand, a marketing-led firm with a well-oiled machine independent of any individual can usually show a healthy, growing pipeline because of the mechanised, multi-channel, campaign orientated and measured approach to lead generation. Companies like this would be able to attract a premium price from an investor. And if they are at the top end of the scale, they will be able to demonstrate the qualitative factors attracting premium valuations below.
There are four key performance indicators that would be taken into account in a valuation:
- Pipeline – A premium value would be placed on a firm with 75% of its pipeline as business booked over the next three months and 50% booked over the next six months
- Sales Growth – 15% consistent year-on-year growth would be viewed as strong, but 25% would win a premium valuation
- Repeat Business – A firm with 80% repeat business would be seen as strong, and 90% would win a premium value
- Client Relationships – Valuation would increase where long term client relationships are prominent, and a discount would be applied if too many eggs are in one basket in terms of client concentration.
It’s important to understand that valuation is not a science and other factors such as synergy with the buyer have a major influence, so the figures above should be taken as guidelines. However, a firm’s ability to demonstrate numerically the growth and repeatability of sales is always going to attract higher multiples. Conversely, those that can’t demonstrate robust processes in sales and marketing may never achieve a sale or investment.
So let’s assume you are able to present a positive picture and are well placed to take your firm to market.
How do I find out if my firm is attractive to buyers?
Talk to advisors who have experience in mergers and acquisitions and people who have bought and sold consulting firms. They will know the market and how to evaluate the attractiveness of a firm of your size, market, and services.
They will not only take into account how similar companies have sold in recent times and the current demand for companies with your services/niche/geographic markets, buyers will also be willing to pay a premium for firms with a high degree of synergy to themselves. If a buyer really wants what you are selling and you are the perfect strategic fit, then you can achieve an even higher price for your firm.
Remember to be calculated and cautious in the early stages; you can’t take every positive conversation too seriously. You may hear a lot of flattery when you put your firm on the market but the most important thought to keep in mind is the golden rule of selling your firm: ‘one buyer – no buyer’ and aim to achieve a bidding contest for your firm.
When is the best time to sell?
The best time to sell is when the following three areas are in line and on the increase:
- A peak in market activity (such as now)
- A peak in your own profits
- A peak in your market sector.
If these three things coincide and you go to market at a time when you have an excellent sales track record and clients are singing your praises, then you stand a very good chance of getting the maximum value for your firm.
What are the various exit options and how do I choose the right one?
There’s a wide range of options to sell your company or release equity value, but there are five main routes available to you.
- Trade Buyer – Usually a strategic acquisition by another consulting firm, or services business which believes that your firm can further its growth ambitions, possibly by extending their geographic footprint, widening their service portfolio, or increasing capacity.
- Investment House – This is usually a purely financially motivated investment. There are a growing number of private equity houses that now see consulting as a good market to invest in because of its reputation for high profit margins and low overheads, thus delivering a good return to its investors.
- Bank Debt – This is where bank debt is used to fund smaller shareholders to buy-out larger shareholders, without necessarily giving up any of their equity to the bank.
- Management Buy-Out (MBO) - This is when some of your senior team buys out the founder or other larger shareholders.
- Stock Market Floatation – An option for bigger companies is to float the business on the stock market. This would require a fairly large sales turnover figure to qualify and it varies by stock market, but would probably require at least $40m sales turnover as an entry point.
So, how do you choose?
Size will rule out some of the options, but you need to consider if want to sell out completely or be involved at the next stage of growth. If you want to sell out completely and move on, then selling to a trade buyer who will take on your firm lock, stock, and barrel could be the option for you.
If you only want to relinquish part of the business, then perhaps look at a private equity investor or a bank. If this is the case, ensure you redistribute your shareholding so that your management team is motivated to continue to work hard and do their best for the business during any changes.
How do I prepare for a sale?
Preparation is the key because if a buyer’s due diligence discovers nasty surprises, then the deal could be jeopardized or your firm could be devalued. It will normally take about three to six months to get your firm prepared for sale and it will be a big distraction to normal business.
So it’s a great opportunity to make use of Chairmen, Finance Directors, and so on. Get them to go through things with a fine toothcomb whilst the management team stays focused on growing the business.
There are two main areas to focus on to reduce the risk of nasty surprises: operations and finances.
Scrutinize and clean up all your operations by removing any negative issues, or implementing quality changes that will reinforce future profits. This may include removing errant shareholders or employees, dealing with impending litigation, streamlining teams, or ensuring that client, supplier, and employee contracts are sound and in place.
It’s vital to clear out any dubious assets or expenses, such as private yachts, or odd payments to people who aren’t strictly employees. Keep it legal and make sure your accounts are squeaky clean.
Finally, and this is most important, whilst sharpening the act, clearing skeletons out of cupboards, and making things nice and transparent, make sure you have a strong sales pipeline to back up your profit forecast—otherwise you won’t be going anywhere!
However if you follow the path we’ve recommended in this series of articles, you could be looking at a very wealthy future, not only for yourself but other shareholders in the business.
These are the main points we’ve discussed in this three-article series:
- In simple terms, your firm is worth a multiple of your last 12 months profits
- This relies on the risk of profits continuing over future years
- Use ‘The Eight Levers of Equity Value’ to grow your firm and reduce risk
- The most important factor by far is a robust sales and marketing machine
- Of the range of exit options, choose the best one for your circumstances
- Good preparation is the key to ensure a smooth route to the big pay day.
Paul Collins is the founder and Managing Partner of Equiteq LLP, a UK based business advisory firm on M&A to the consulting Industry. Formerly, he was the founder and CEO of the consulting firm WCI Group plc, which he built from scratch to $130m before selling his stake to private equity. He is now Europe’s pre-eminent authority on M&A in the consulting industry. Find out more at www.equiteq.com.